Prospect theory, reference points, and health decisions

2007

5th International Scientific Research E-Congress (IBAD-2020), 2020

This article presents a review of prospect theory which was an alternative model for expected utility theory. The objective of this paper is to examine in detail the original work of Kahneman and Tversky (1979) entitled ‘Prospect theory: An analysis of decision under risk’. Their work is aimed to demonstrate how the expected utility theory of the economic model was inadequate and inconsistent in explaining the human decision-making process. They came with a more convincing model called prospect theory. The theory contains two basic stages for choice decision-making. These are the editing stage and the evaluation stage. The theory stated that carriers of utility are changes in the existing state of affairs, rather than the final state. However, changes in the existing state of affairs and the final state are interdependent. Hence, we should consider value(utility) as a function of the current state of affair (reference point) and the size of change from that reference point i.e., positive or negative. For example, for the person who already owns specific assets, purchasing the same additional asset may bring less value (utility) than the value (utility) it will bring to a person who does not own that specific asset. According to the expected utility theory, two individuals should have the same level of utility for the same amount of gain or loss. However, in prospect theory, the same amount of gain or loss does not bring the same feeling for two different persons or, even for a single person. Kahneman and Tversky(KT) suggest that their theory can be extended to the particular situation of prospects in which the likelihood of the events is not quantified. They also stated that as long as the outcomes are coded as gains and losses relative to the standard point, the proposed value function for money can be valid for other nonmonetary attributes. KT popular theory (PT) was later extended in several angles by themselves and by other researchers. The applications of the prospect theory are not only limited to the monetary attributes but also for other non-monetary aspects such as Political science, Cognitive neuroscience, and other areas that require the decision-making process.

Journal of Risk and Uncertainty, 1992

We develop a new version of prospect theory that employs cumulative rather than separable decision weights and extends the theory in several respects. This version, called cumulative prospect theory, applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting functions for gains and for losses. Two principles, diminishing sensitivity and loss aversion, are invoked to explain the characteristic curvature of the value function and the weighting functions. A review of the experimental evidence and the results of a new experiment confirm a distinctive fourfold pattern of risk attitudes: risk aversion for gains and risk seeking for losses of high probability; risk seeking for gains and risk aversion for losses of low probability. Expected utility theory reigned for several decades as the dominant normative and descriptive model of decision making under uncertainty, but it has come under serious question in recent years. There is now general agreement that the theory does not provide an adequate description of individual choice: a substantial body of evidence shows that decision makers systematically violate its basic tenets. Many alternative models have been proposed in response to this empirical challenge (for reviews, see Camerer, 1989; Fishburn, 1988; Machina, 1987). Some time ago we presented a model of choice, called prospect theory, which explained the major violations of expected utility theory in choices between risky prospects with a small number of outcomes (Kahneman and Tversky, 1979; Tversky and Kahneman, 1986). The key elements of this theory are 1) a value function that is concave for gains, convex for losses, and steeper for losses than for gains, *An earlier version of this article was entitled "Cumulative Prospect Theory: An Analysis of Decision under Uncertainty." This article has benefited from discussions with Colin Camerer, Chew Soo-Hong, David Freedman, and David H. Krantz. We are especially grateful to Peter P. Wakker for his invaluable input and contribution to the axiomatic analysis. We are indebted to Richard Gonzalez and Amy Hayes for running the experiment and analyzing the data.

International Journal of Social Science and Economic Research, 2019

Prospect Theory (Kahneman and Tversky, 1979) is a highly influential theory that predicts decision making when people are confronted with choices involving gains or losses with different degrees of uncertainty. Prospect Theory argues that people are generally risk averse when it comes to seeking gains and risk seeking when it comes to seeking losses. However, Prospect Theory was originally created using hypothetical decisions. As a result, Prospect Theory has had mixed results when subject to testing in real-world decision-making contexts. One reason for this is that people tend to have goals that they are trying to achieve or outcomes they are trying to avoid when making their decisions, something Prospect Theory does not take into account. The present research investigates the effects of such goals (called "aspiration levels") and avoidance outcomes (called "avoidance levels") on decision making. As a result, we hypothesize that, for decisions involving gains, people will be risk seeking until they achieve their desired goals (the opposite of what Prospect Theory predicts) and risk averse thereafter, and for decisions involving losses, people will be risk averse until they reach their avoidance levels (the opposite of what Prospect Theory predicts) and risk seeking thereafter. These hypotheses were testing using active duty military officers (real world decision makers) making choices among military options in scenarios involving gains and losses. The officers' decisions fit the pattern predicted by our revised Prospect Theory framework. Results suggest that understanding decision making must take into account the goals of the decision maker and whether they expected outcomes of those decisions will place the decision maker in terms of aspiration and avoidance levels.

Journal of Market Access & Health Policy

It is widely acknowledged that using p-value thresholds as the basis for making decision on health care spending is not appropriate. In the context of medical decision making, we argue that patient preferences need to be a stronger factor. Depending on attitudes to risk, patients might prefer a medical treatment that performs on average worse than a comparator but offers a small probability of a large gain such as a cure. However, what has been labeled 'value of hope' is not yet fully reflected in the decision-making process of drug approval and health technology assessment (HTA). Therefore, patient risk preferences should be formally incorporated within the decision-making framework for regulatory and reimbursement decisions.

2018

The main focus of this tutorial/review is on presenting Prospect Theory in the context of the still ongoing debate between the behavioral (mainly descriptive) and the classical (mainly normative) approach in decision theory under risk and uncertainty. The goal is to discuss Prospect Theory vs. Expected Utility in a comparative way. We discuss: a) which assumptions (implicit and explicit) of the classical theory are being questioned in Prospect Theory; b) how does the theory incorporate robust experimental evidence, striving, at the same time, to find the right balance between the basic rationality postulates of Expected Utility (e.g. monotonicity wrt. First-Order Stochastic Dominance), psychological plausibility and mathematical elegance; c) how are risk attitudes modeled in the theory. In particular we discuss prospect stochastic dominance and the three-pillar structure of modeling risk attitudes in Prospect Theory involving: the non-additive decision weights with lower and upper s...

British Journal of General Practice, 2013

Journal of Risk and Uncertainty, 2012

In previous models of (cumulative) prospect theory reference-dependence of preferences is imposed beforehand and the location of the reference point is exogenously determined.

Nature Human Behaviour, 2020

Kahneman and Tversky's 1979 article on Prospect Theory is one of the most influential papers across all of the behavioural sciences. The study tested a series of binary financial (risky) choices, ultimately concluding that judgments formed under uncertainty deviate significantly from those presumed by expected utility theory, which was the prevailing theoretical construct at the time. In the forty years since publication, this study has had a remarkable impact on science, policy, and other real-world applications. At the same time, a number of critiques have been raised about its conclusions and subsequent constructs that were founded on it, such as loss aversion. In an era where such presumed canonical theories have increasingly drawn scrutiny for inability to replicate, we attempted a multinational study of N = 4,099 participants from 19 countries and 13 languages. The same methods and procedures were used as in the original paper, adjusting only currencies to make them relative to current values, and requiring all participants to respond to all items. Overall, we found that results replicated for 94% of the 17 choice items tested. At most, results from the 1979 study were attenuated in our findings, which is most likely due to a more robust sample. Twelve of the 13 theoretical contrasts presented by Kahneman and Tversky also replicated, with a further 89% replication rate of the total contrasts possible when separating by location, up to 100% replication in some countries. We conclude that the principles of Prospect Theory replicate beyond any reasonable thresholds, and provide a number of important insights about replications, attenuation, and implications for the study of human decision-making at population-level.

2005

During the last twenty-five years, prospect theory (and its successor, cumulative prospect theory) replaced expected utility as the dominant description of risky decision making. Although these models account for classic paradoxes, eleven new paradoxes show where prospect theories lead to self-contradiction or false predictions. The new findings are consistent with and, in several cases, were predicted by simple "configural weight" models in which probability-consequence branches are weighted by a function that depends on branch probability and ranks of consequences on discrete branches. Although they have some similarities to models later called "rankdependent," these models do not satisfy coalescing, the assumption that branches leading to the same consequence can be combined by adding their probabilities. Nor do they satisfy cancellation, the "independence" assumption that branches common to both alternatives can be removed. The transfer of attention exchange model, with parameters estimated from previous data, correctly predicts results with all eleven new paradoxes. Apparently, people do not frame choices as prospects, but instead, as trees with branches.